Libra: An international currency with universal validity ?

I’ll admit, there’s general confusion at this stage about the viability of Libra, the fiat-backed stablecoin being engineered by Facebook.

For some, it speaks to the trend of digitisation in the financial services industry and the pace at which innovation in the private sector is surpassing that of governmental institutions. Many are discussing the political implications of Libra being a “basket”-denominated stablecoin versus a dollar-pegged stablecoin (although just recently we learned that Libra may pivot and instead use a number of fiat currency-pegged stablecoins).

For others, it is a frightening proposal of what a de-dollarised global financial system could look like. For all that Libra will or will not be, I think it is much too early to judge its future. After all, it is not due to launch until June 2020 (or later).

So let’s take a step back and consider the fact that Libra is not an entirely new concept. Economists have proposed similar versions of an “international currency” in the past, but to no avail. The timing may be ripe for Libra, however, given the increasing role of cryptocurrencies and stablecoins in the face of today’s global economic and political climate.

Keynes’ international currency proposal: Bancor (no, not the cryptocurrency)

In 1941 during the Bretton Woods era, British economist John Maynard Keynes brought forth the proposal for an International Clearing Union (ICU), a global bank, to facilitate international trade payments and settlement. The common unit of account, the Bancor, would be a multi-asset basket unit for multilateral clearing and settlement. The purpose? To find a solution for moderating global trade (and power) imbalances. Through an expansionist view, Keynes wanted to propose an international framework for facilitating the growing post-war global trade economy and, in particular, the balance between creditor and debtor countries.

Countries such as the US, which runs a large trade deficit, would be charged interest on its Bancor account if the deficit balance were more than half the size of its overdraft facility. Additionally, the US would be forced to devalue the US Dollar and implement capital control measures accordingly. China, on the other hand, which currently runs a large trade surplus, would be similarly penalised by owing interest and being forced to increase the value of the Yuan etc… You could imagine how maintaining this balance would be a particularly contentious topic in light of the current US-China trade war. (An interesting experiment would be to think about how the US-China economic relations would be different today had the ICU been successfully implemented…)

There is plenty of reading available on the subject, but here are some notable points:

Advantages

  • Promote multi-lateral agreements over multiple bilateral agreements (and thus fragmented policies)
  • Prevent competitive exchange depreciation
  • Serve as an “internal stabilising mechanism” to ensure equal balance of payments amongst countries

Disadvantages

  • Rely on international gold currency aka fixed exchange rate system
  • Require rigid financial control to maintain fixed exchange rates
  • The United Kingdom and the United States would be founding members (and unclear whether this would have meant that they could have more power in “governing” the ICU)

Variation to Bancor: Kosmos (again, not the cryptocurrency)

In 2018 former Greek finance minister, Yanis Varoufakis, proposed a variation of Keynes’ earlier ICU system suggesting the creation of a new international monetary system with a common digital currency called Kosmos.

Kosmos would be issued and regulated by the International Monetary Fund (IMF). Instead of being fixed to the gold standard, however, the exchange rates between Kosmos and the reserve fiat currencies backing it would be variable, similar to how the IMF’s Special Drawing Rights (SDR) operates. Along similar lines as Keynes, Varoufakis believes that the bigger the balance of payments surplus or deficit, the greater the risk of instability. And that global institutions, not the market, should be the ones to maintain proper balance of capital flow between countries. In effect, the international monetary agreement penalises countries for not running “at equilibrium” and was another attempt to regulate global trade and capital imbalance [1].

Most importantly, neither Bancor nor Kosmos was designed to be used for daily transactions of goods and services. The international currencies would merely serve as unit of accounts to be transacted via a national institution (i.e Treasury or Central Bank). Private individuals, businesses, and commercial banks would continue to use and circulate fiat currencies in the same manner we do so today. Both Bancor and Kosmos were merely designed to be a supranational capital transfer mechanism alongside the circulation of fiat currencies. Monetary policy would still be in the hands of governments.

Libra: A new global, super-sovereign currency?

Libra adds another dimension to the idea of an international digital currency. Libra is designed not by policymakers for a network of governmental institutions, but by a private corporation for everyday use by the private individual. Empowering mission right? If successful, you better bet that it will be in direct competition with sovereign money. Just imagine, what would a world with Libra look like?

Mark Carney presented a few ideas in his recent speech at the Jackson Hole Economic Symposium. Carney is in favor of reducing the US Dollar’s dominance as the de facto currency for international trade invoicing and settling. The “global financial cycle”, as he explains, is in fact a “dollar cycle.” The US has a heavy influence on the rest of the world via the US Dollar and he advocates for a global digital currency or network of central bank digital currencies as a possible replacement. He believes that “the dollar’s influence on global financial conditions could decline if a financial architecture developed around the new Synthetic Hegemonic Currency (SHC) and it displaced the dollar’s dominance in credit markets.” [2]

“Change demands transformation and it shouldn’t be to swap one currency hegemon for another” — Mark Carney (Outgoing Bank of England Governor)

Could the Libra Association encroach on the role that central banks hold today? During the US hearings for Libra, some congress skeptics expressed their concern that Libra is an attempt to create a global currency to compete with the US Dollar. Despite the Association’s public posturing, I believe this is Libra’s long term goal: to reinvent money for the internet age.

We are already seeing a broader trend of de-dollarisation globally. Why venture on such a daring project if the goal isn’t to disrupt the legacy financial system for the better? This said, however, critics are right. What would incentivise the US government to support a stablecoin that could one day replace the US Dollar?

What is Libra anyways?

It’s likely you’ll come across cryptofolk imposing Bitcoin’s “peer-to-peer version of electronic cash” manifesto onto Libra. Sure, both aim to be seen as the new money of the internet age but Libra is foremost not a cryptocurrency.

While it’s still unclear what Libra will be, the current proposal behind Libra is a stablecoin backed by an offshore reserve of fiat currencies and government debt to support stability and capital preservation. Namely, Libra’s reserve will be SDR-like with 50% United States dollar, 18% Euro, 14% Japanese yen, 11% Pound sterling and 7% Singapore dollar. The reserve will be operated by an independent Libra Association, of which members will each be responsible for running a validator node of the Libra Blockchain network. Libra is very much linked to the existing fiat system and has a laser-focused commercial purpose: to lower the costs of domestic and cross border payments. Instead of using physical fiat monies, individuals would be able to directly transact Libra in the digital realm from smartphones instead of relying on payment transfer intermediaries such as Western Union. It is designed to empower an individual’s ownership of money by removing the operational (and costly) friction that comes with payment transfers today.

Let’s take a look at the notable characteristics of Libra:

Politically-straddled

  • Fiat currencies are inherently political — issued and controlled by a single sovereign government. Libra is politically-straddled — created by a private corporation and supposedly pegged to multiple sovereign currencies.

Freely tradeable, transferable in an instant

  • The transferring of fiat currencies between bank accounts requires a banking intermediary which often times may take days to settle. Theoretically, Libra can be transferred between wallets within minutes.

Facebook’s 2.4B+ person user base

  • Facebook can tap into its enormous, 2.4 billion+ person user base to gain more adoption of Libra than any other cryptocurrency or bank in the world.

Challenges ahead

Libra’s theoretical convenience is the reason critics argue that the stablecoin will likely be used for financing nefarious activities and facilitating hot money (this is the same “darknet”/money laundering problem critics have with Bitcoin). They fear that mass adoption of Libra will force unintended consequences on the global economy (for more on this, I recommend Mike Pettis’ article). What governments fear most is losing power.

“A core element of state sovereignty is the publication of a currency, we will not leave it to private companies” — Olaf Scholz (German finance minister) [3]

Libra could set a precedence for gradually democratising monetary sovereignty amongst central banks. It is forcing governments worldwide to make a decision: cooperate or go another path (i.e China). Inaction is not an option. At the very least, Libra is putting pressure on central banks to think seriously about creating their own Central Bank Digital Currency (CBDC). This article by the Financial Times aptly describes Libra’s unintended role in “injecting political urgency into a technical debate previously confined to the research papers of central banks.” [4]

So next time someone asks you to describe what Libra is “in a nutshell”, lean on this for now: Libra is still figuring itself out but its mere conception is prioritising the conversation about digital currencies on the national and supranational stage.

References

[1]: Yanis Varoufakis. 2008 and the International New Deal we need for the post-2018 world https://www.yanisvaroufakis.eu/2018/09/18/2008-and-the-international-new-deal-we-need-for-the-post-2018-world-oecd-keynote-14-sep-2018/

[2]: Mark Carney. Enable, Empower, Ensure: A New Finance for the New Economy https://www.bankofengland.co.uk/-/media/boe/files/speech/2019/enable-empower-ensure-a-new-finance-for-the-new-economy-speech-by-mark-carney.pdf?la=en&hash=DC151B5E6286F304F0109ABB19B4D1C31DC39CD5

[3]: Coindesk. German Finance Minister Supports Digital Euro, But ‘Very Critical’ of Libra https://www.coindesk.com/german-finance-minister-supports-digital-euro-but-very-critical-of-libra

[4]: Financial Times. How Facebook’s Libra fuelled push for central bank-run digital currencies https://www.ft.com/content/746808a0-d9f6-11e9-8f9b-77216ebe1f17

Head of Institutional Sales @ Amber Group | Host of the Crypto Unstacked Podcast | Interdisciplinary Thinker